With its stock down 10% over the past three months, it is easy to disregard Spark New Zealand (NZSE:SPK). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on Spark New Zealand's ROE.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Spark New Zealand is:
26% = NZ$384m ÷ NZ$1.5b (Based on the trailing twelve months to June 2021).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every NZ$1 worth of equity, the company was able to earn NZ$0.26 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of Spark New Zealand's Earnings Growth And 26% ROE
First thing first, we like that Spark New Zealand has an impressive ROE. Secondly, even when compared to the industry average of 7.6% the company's ROE is quite impressive. Given the circumstances, we can't help but wonder why Spark New Zealand saw little to no growth in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
As a next step, we compared Spark New Zealand's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 11% in the same period.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for SPK? You can find out in our latest intrinsic value infographic research report.
Is Spark New Zealand Using Its Retained Earnings Effectively?
Spark New Zealand has a very high three-year median payout ratio of 110% over the last last three years, which suggests that the company is dipping into more than just its earnings to pay its dividend. The absence in growth is therefore not surprising. Paying a dividend higher than reported profits is not a sustainable move. This is quite a risky position to be in. You can see the 3 risks we have identified for Spark New Zealand by visiting our risks dashboard for free on our platform here.
Moreover, Spark New Zealand has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 102%. Still, forecasts suggest that Spark New Zealand's future ROE will rise to 31% even though the the company's payout ratio is not expected to change by much.
Overall, we have mixed feelings about Spark New Zealand. While the company does have a high rate of return, its low earnings retention is probably what's hampering its earnings growth. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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